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Guarantees gone mild

Labels vary, but one word characterizes the adjustments many carriers are making to their guarantees in reaction to the financial crisis: necessary.

"We're seeing it with most of the big carriers -- reductions in the richness of their [income] guarantees, outright elimination of some guarantees and fee increases," says Scott DeMonte, director of variable annuity markets at Financial Research Corp., a Boston-based financial research and consulting firm. "When you look at the systematic risk of these things, I think [the changes] had to happen. The cost of hedging these benefits has gone through the roof.

"I look at these changes as a good thing," he continues. "They (insurers) are taking steps to ensure that these benefits will be around and provide value. That they have a long-term success rate with these features, I think, is critical."

For insurers, the future for hugely popular living benefits comes down to a balancing act. Their challenge: to provide lifetime income features robust and reasonably priced enough to still resonate with investors while also protecting themselves (read: shareholders) from the risk inherent in those guarantees. Meeting that challenge will require creativity, says Tom Mullen, vice president of marketing at John Hancock Annuities. "Everybody's [product development] labs are busy working on this stuff."

They are busy because the financial meltdown precipitated an end to the high-stakes game of living benefits one-upmanship that many carriers in the VA space had been playing. Crisis or not, that "arms race" had to end, according to Mullen, because it was getting too expensive for insurers to hedge the higher risks in offering increasingly aggressive withdrawal, accumulation and income guarantees. Now, he says, comes a period of living benefits "disarmament." Instead of rolling out more aggressive step-up provisions and guaranteed income percentages in their GMIBs and GMWBs, carriers are rolling back perks.

"We've had to scale back the risk profile of these products because, pound for pound, the price of volatility today is substantially higher than it was a year ago," explains Mullen. Hancock has increased the cost of some of its VA income guarantees by 10 basis points, for example, while, Prudential, another major player in the VA market, has raised the annual fee for its base HD Lifetime Seven living benefit option from 60 to 75 basis points. They are not alone. Throughout the last two quarters, the cost of living benefits rose industry-wide by 20 percent to 30 percent -- "a little more than 10 basis points" -- on average, says DeMonte.

Cost increases are only part of the story. Some carriers have reduced accumulation and withdrawal percentages while others have dropped their highest income guarantees from the product mix altogether, notes DeMonte. Some are rolling back the frequency of step-up provisions from quarterly to annually, adds Mullen, while others are pushing back the age levels associated with the banded interest rates embedded in their guarantees. Prudential, for one, recently adjusted the age ranges linked to specific withdrawal percentages in HD Lifetime Seven.

The news about living benefits isn't entirely negative, however. Many carriers are packaging rollbacks with modest but meaningful enhancements to the very same options, notes Bob O'Donnell, Prudential's senior vice president for product development. In disclosing plans in February to hike annual fees on HD Lifetime Seven, it also revealed a range of enhancements, including fewer restrictions on partial withdrawals, new pre-withdrawal step-up opportunities and richer protected withdrawal values. Further, he notes, Prudential has left intact the daily step-up feature that made HD Lifetime Seven unique when it was introduced in early 2008 (and later earned accolades from Boomer Market Advisor readers who named it "the living benefit that best addresses the income and longevity issues clients face"). HD Lifetime Seven offers a protected withdrawal value based on 7-percent annual compounded growth on the highest daily account value, with a 5 percent to 8 percent income stream guaranteed for life.

Today about 80 percent of variable annuity purchasers elect to attach some type of living benefit to their contracts, according to DeMonte. At Prudential, the overall election rate for optional living benefits on VAs sold in the first nine months of 2008 was 85 percent. Among the various kinds of optional living benefits, lifetime income guarantees represent a vast majority, according to DeMonte. While variable annuity net flows have decreased markedly in the wake of the financial crisis, DeMonte doesn't expect the consumer appetite for income guarantees to diminish because of recent actions by insurers. If anything, he says, the appeal of such guarantees will only increase as investors gravitate to insurance features that assure retirement income and protect their assets.

Mullen concurs. "The investor base is a year older, a year closer to the age they thought they would retire and now they are finding themselves in a much worse financial position. It's making more people realize there's value to a [retirement income] guarantee."

O'Donnell also sees variable annuity income guarantees appealing to retirement-minded investors seeking a new long-term home for the money they stashed short-term in conservative vehicles such as CDs to weather the storm of 2008. Eventually, those investors will look to reinvest that money in long-term vehicles that offer equity market participation in tandem with guarantees to minimize downside risk, he says. "From that perspective, I'm very optimistic."

Recent fee hikes aren't likely to deter those types of investors from purchasing living benefit features, says DeMonte. "I think once people weigh the costs and benefits, they'll be fine with paying a little extra for a guarantee."

While the financial turbulence may have temporarily dampened the spirit of innovation in the VA space, all is not quiet on the living benefit front. DeMonte cites Sun Life's Income On Demand feature as a sign of where the market could be heading. Touted as the industry's first "income storage benefit" when it was introduced in 2007, Income On Demand is available with Sun Life Financial Masters variable annuities. It allows contract-holders to defer part or all of their allowed annual withdrawals and to "store" those withdrawals in the contract for future use -- similar in most respects to a GMWB, but with cumulative withdrawal capability. Last October, Sun Life rolled out its Income On Demand II Suite, which includes new storage features, escalators and bonuses.

Annuity companies are also unveiling income features with a wealth transfer spin. Jackson National Life's LifeGuard Freedom DB optional rider, for example, provides guaranteed lifetime withdrawals, with step-up opportunities, plus guarantees that the contract holder's death benefit amount will not decrease, provided withdrawals do not exceed the guaranteed annual limit or minimum required distribution. Meanwhile, with its HD Lifetime Seven and Spousal HD Lifetime Seven riders, Prudential offers a beneficiary income option that gives beneficiaries the option of electing to receive annual income payments instead of the base death benefit from the underlying annuity.

Prudential and other carriers are also rolling out income-acceleration features to help contract-holders cover unforeseen expenses such as long-term care. Prudential's Lifetime Income Accelerator, for example, allows annuity owners to double their annual income amount in the event they need long-term care, either at home or in a nursing facility.

VA living benefits in many instances will cost somewhat more and deliver somewhat less than they did before the havoc hit global financial markets in 2008. But beneath the surface, says Mullen, the "core value proposition [of VA living benefits features] hasn't changed. The changes we have seen haven't radically altered the structural integrity of the annuity. All we've done is kind of trimmed the branches a bit."